How to Use State Pass-Through Entity Tax Elections to Bypass the SALT Cap

The $10,000 SALT deduction cap imposed by the Tax Cuts and Jobs Act of 2017 (P.L. 115-97) gutted the state tax deduction for millions of high-earning pass-through business owners. The state pass-through entity (PTE) tax election is the IRS-sanctioned workaround: the entity pays state income tax on owners' behalf, claims a full federal deduction at the entity level, and passes a state tax credit to each owner. As of 2026, 36 states and the District of Columbia have enacted PTE election laws. For clients in high-tax states with pass-through income above $150,000, implementing the election can deliver $5,000–$30,000+ in federal tax savings annually.

This guide walks through the mechanics, eligibility rules, step-by-step implementation, and the most common pitfalls CPAs encounter.

OBBBA Update (2026): The One Big Beautiful Bill Act raised the individual SALT cap from $10,000 to $40,000 for taxpayers with MAGI below $500,000. This changes the calculus for some clients — if a client's total state income tax on pass-through income is below the new $40,000 cap, a PTE election may no longer add value. See SALT Cap at $40,000: How OBBBA Changes the State Tax Deduction for the macro picture, SALT Cap and PTET Elections After OBBBA: When to Keep, Modify, or Drop the Election for the income-band analysis and QBI interaction details, and State PTET Elections in 2026: The CPA's Planning Guide After OBBBA for the 2026 state conformity matrix and election deadline calendar.

Why PTE Elections Work: The IRS Authority

The SALT cap under IRC §164(b)(6) limits the deduction for state and local taxes paid by individuals to $10,000. It does not apply to taxes paid at the entity level. Pass-through entities — S-Corps, partnerships, and multi-member LLCs — pay no federal income tax, but the TCJA did not restrict entity-level state tax deductions.

In November 2020, the IRS released Notice 2020-75, confirming that a partnership or S-Corp may deduct state and local income taxes imposed on and paid by the entity as a deduction in computing its non-separately stated taxable income. This deduction flows through to each owner as a reduction in ordinary income — effectively sidestepping the individual SALT cap entirely.

The mechanics work because:

1. The entity pays state income tax on the pass-through income (rather than owners paying individually)
2. The entity deducts that payment as an ordinary business expense under IRC §164(a)
3. Each owner receives a state tax credit equal to their share of the tax paid, offsetting their state liability
4. The net result: federal AGI is reduced by the PTE tax paid, with no corresponding SALT cap limitation

Key authority:

• IRC §164(a) — entity-level state tax deductions
• IRC §164(b)(6) — the $10,000 individual SALT cap (does not apply to entities)
• IRS Notice 2020-75 — confirmed entity-level deduction is permissible
• Rev. Rul. 71-190 — foundational principle that taxes imposed on a pass-through entity are deductible at the entity level

Prerequisites

Before proceeding, confirm these conditions are met:

• The client has a qualifying pass-through entity: S-Corp, partnership, multi-member LLC taxed as a partnership, or LLC taxed as an S-Corp
• The entity operates in (or the owners are taxable in) a state that has enacted a PTE election law
• The owners are individuals (not corporations) — corporate owners generally cannot benefit from the personal credit
• The owners itemize federal deductions, or even if they take the standard deduction, the PTE election still reduces pass-through income flowing to their Schedule E (so it benefits both itemizers and non-itemizers)
• The client can fund the entity-level tax payment (liquidity planning is essential)

Note on non-itemizers: Many CPAs assume PTE elections only benefit itemizing clients. This is wrong. Because the deduction reduces the entity's ordinary income before it passes through to Schedule E, it reduces federal taxable income regardless of whether the owner itemizes. The benefit flows through the K-1, not through Schedule A.

Step 1: Determine If Your Client's State Offers a PTE Election

As of early 2026, 36 states and DC have enacted PTE election legislation. State rules vary significantly. Check the following for each state where the entity pays state income tax:

High-tax states with active PTE elections (highest client impact):

State	Key Features
California	9.3% rate on net income ≥ $1; annual election due by original return deadline; credit equals 100% of tax paid; effective for tax years beginning on or after January 1, 2021 (CA Rev. & Tax. Code §19900 et seq.)
New York	NY PTET at graduated rates (6.85%–10.9%); election made online through Business Online Services by March 15 of the tax year (or by Oct 15 for prior year); estimated payments required quarterly; individual credit fully offsets NY income tax (NY Tax Law §860)
New Jersey	Partnerships: mandatory BAIT (Business Alternative Income Tax); S-Corps: elective; rate 5.675%–10.9% on distributive share; credit refundable for NJ residents (N.J.S.A. 54A:12-1 et seq.)
Illinois	Elective PTE tax at 4.95% flat; credit equals 100% of tax paid; election made on entity return (35 ILCS 5/201.2)
Massachusetts	Elective ELT at 5%; annual election on entity return; fully creditable against individual income tax (G.L. c. 63D)
Connecticut	Mandatory for most pass-throughs; base rate 6.99%; credit equals 87.5% of tax paid (CGS §12-699)
Maryland	Elective at 8% for individual members; credit equals tax paid (MD Code Tax-Gen §10-102.1)
Virginia	Elective at 5.75%; election made on Form 502PTET; estimated payments required (Va. Code §58.1-390.3)
Georgia	Elective at 5.75%; election irrevocable once made for the tax year (O.C.G.A. §48-7-27.3)
Colorado	Elective at 4.4% (2024+ rate); annual election on entity return (C.R.S. §39-22-343)
Oregon	Elective PTE-E at 9%; election on annual return; credit fully creditable (ORS §316.090)

States with no individual income tax (PTE election irrelevant or unavailable): Nevada, Wyoming, South Dakota, Florida, Texas, Alaska, Washington (no individual income tax; no SALT issue to solve), New Hampshire (no wage/salary income tax — limited applicability)

For states not listed above, verify current law through the state revenue department or AICPA's state PTE tracker. Laws change frequently, and some states have enacted elections after 2023.

Step 2: Assess Whether the Election Generates a Net Benefit

Not every client benefits equally. Run this analysis before recommending the election:

Federal benefit calculation:

1. Identify the entity's state taxable income attributable to each owner
2. Calculate the estimated PTE tax (apply state rate to owner's share of entity income)
3. Multiply the PTE tax by the owner's marginal federal rate (typically 32%, 35%, or 37% for high-earners)
4. That result is the federal tax savings

State cost check:

• Confirm the credit covers 100% of the PTE tax paid (most states: yes; Connecticut: 87.5%)
• If the credit is less than 100%, there's a net state cost — factor into the analysis
• Verify the credit is refundable or can carry forward if it exceeds the owner's state liability

Simplified example:

Client owns 60% of an S-Corp with $500,000 in ordinary income. Client is in New York (PTET rate ~6.85% blended). PTE tax attributable to client: ~$34,250. Federal savings at 37% marginal rate: $34,250 × 37% = $12,673. Client receives a NY state credit of ~$34,250 (100% of tax paid). Net result: $12,673 federal tax reduction at essentially no net cost.

For clients with pass-through income above $150,000–$200,000 in high-tax states, the election is almost always favorable. The break-even point depends on the state rate and the owner's federal marginal rate.

See our guide to S-Corp vs LLC tax structures for context on how entity choice interacts with PTE election availability.

Step 3: Make the Election — Timing and Mechanics

Election deadlines vary by state and matter enormously. Missing the deadline typically means losing the election for the entire tax year.

Common deadline patterns:

• By original return due date (most states): March 15 for S-Corps/partnerships (Form 1065/1120-S); September 15 with extension in many cases
• During the tax year (New York): Election must be made by March 15 of the current tax year for that year's election — retroactive elections are not permitted
• At filing (California): Election is made on the entity's original or amended return; for CA, a payment must be made by June 15 of the tax year to be valid

Action items:

1. Identify each state's election deadline for the upcoming tax year — calendar these for all qualifying clients
2. Confirm the election method (online filing vs. checked box on the entity return vs. separate election form)
3. For New York clients, execute the election in January or February of the tax year — do not wait until filing
4. Document the election with the client via email or engagement letter addendum

Multi-owner entities: All owners typically must consent to (or be notified of) the election. In some states (e.g., California), the election requires agreement from owners holding a majority interest; in others, the managing partner/shareholder-officer can make the election unilaterally. Review state law before proceeding for entities with multiple owners.

Step 4: Calculate and Fund the PTE Tax Payment

The entity must actually pay the state PTE tax — either through estimated payments during the year or with the return filing. Late or insufficient payments can result in penalties and may undermine the deduction.

For states requiring estimated PTE tax payments (New York, New Jersey, Virginia, others):

• Calculate the entity's estimated income for the year by end of Q1
• Apply the state PTE rate to each owner's projected share
• Fund quarterly estimated payments through the entity's operating or tax reserve account
• Coordinate with any existing owner-level estimated state payments — once the PTE election is made, owners should not also pay state estimated taxes on the same income (they'll receive the credit instead)

For states allowing payment with the return:

• Ensure sufficient cash is available at the entity level at filing time
• Avoid distributions before year-end that would leave the entity unable to fund the PTE payment

Liquidity planning note: The PTE tax payment increases the entity's cash outflow relative to the pre-election structure (where owners paid state tax individually from distributions). Plan distributions accordingly — owners will receive the credit to offset their individual state liability, but the timing mismatch (entity pays tax, owner gets credit on individual return months later) can create short-term cash pressure.

Step 5: Report on the Entity Return and Pass Credits to Owners

Entity return (Form 1065 or 1120-S):

• Deduct the PTE tax paid as an ordinary business deduction — this reduces the entity's ordinary income before allocation to owners
• Do not separately state the PTE tax on the K-1 as a state tax payment — it is already reflected in the reduced ordinary income figure
• Attach the state PTE election confirmation to the entity return where required

Owner's K-1:

• The reduced ordinary income on the K-1 is the primary mechanism of federal benefit — owners simply report lower pass-through income
• Include a supplemental K-1 note (or separate schedule) showing the PTE tax paid on each owner's behalf, so owners can properly claim the state credit on their individual state returns

Owner's individual state return:

• Owner claims the state PTE credit on their individual state income tax return
• The credit should offset the owner's state income tax liability on the same pass-through income
• In most states, excess credit can carry forward (verify state-by-state — California allows 5-year carry forward; New York allows indefinite carry forward)

For a broader view of how pass-through income flows from entity to individual return, see our guide to year-end tax planning strategies, which covers coordinating entity-level and individual-level planning in Q4.

Step 6: Coordinate With the Federal Return and Estimated Taxes

Federal Form 1040 impact:

• Schedule E, Part II will show reduced ordinary income from the K-1 (reflecting the PTE deduction at the entity level)
• If the owner previously paid state estimated taxes for the pass-through income, they should reduce or eliminate those payments after the election — the entity is now paying
• Recalculate the owner's federal estimated tax payments if the PTE election materially reduces federal AGI

Withholding strategy for owner-employees (S-Corp):

• S-Corp owner-employees paying themselves a reasonable salary can also reduce their estimated federal taxes if their W-2 withholding doesn't fully cover the year's liability
• The PTE election reduces the non-wage K-1 income, which can reduce or eliminate underpayment risk
• See our guide to minimizing self-employment tax for how PTE elections interact with salary and distribution planning

Multi-state entities:

• If the entity operates in multiple states, calculate the PTE benefit separately for each state
• Some states require apportionment; others apply the election only to resident owners' shares
• A California-New York-New Jersey client with a partnership operating in all three states can potentially stack PTE elections in each state (three separate entity-level payments, three separate credits)
• Track each state's election separately; they are not coordinated through a single federal election

Common Mistakes CPAs Make With PTE Elections

1. Missing the in-year election deadline. New York requires the election be made by March 15 of the tax year — not at filing time. CPAs who wait until extension filing in September miss the NY PTET entirely for that year. Calendar all deadlines in January.

2. Failing to reduce owner estimated state taxes. After the entity pays state PTE tax, the owner no longer needs to pay estimated state taxes on that income. Overlapping payments create credit excess and cash flow confusion. Coordinate entity payments and owner estimated payments explicitly.

3. Assuming non-itemizers don't benefit. As explained above, the benefit flows through the K-1 reduction in ordinary income — it doesn't depend on itemizing. This is the most common misconception.

4. Neglecting the credit refundability rules. If an owner's state income tax liability is less than the PTE credit, the excess may not be refundable in some states. For clients with low state income outside the pass-through entity, run a credit utilization analysis before assuming full benefit.

5. Not adjusting QBI deduction calculations. Because the PTE tax reduces the entity's ordinary income before pass-through, the QBI deduction may also be reduced (20% × lower QBI = lower deduction). Model this interaction carefully for clients near the QBI phase-out thresholds. See our QBI deduction guide for the phase-out mechanics.

6. Multi-owner entities without written consent. Some states require documented owner consent or a majority vote. Without it, the election can be challenged or invalidated on audit.

FAQ

What is a pass-through entity tax election?

A PTE election is a state-law mechanism that allows a qualifying pass-through entity (S-Corp, partnership, or LLC) to pay state income tax at the entity level rather than passing the state tax liability to individual owners. The entity claims a full federal deduction for the tax paid under IRC §164(a), reducing the federal taxable income that flows through to owners' Schedule E. Owners receive a state tax credit to offset their individual state income tax on the same income. The result is a federal tax reduction that bypasses the $10,000 SALT cap under IRC §164(b)(6).

Does the PTE election work for S-Corps and partnerships?

Yes. Both S-Corps and partnerships (including multi-member LLCs taxed as partnerships) can use PTE elections in states that allow them. The mechanics differ slightly: S-Corp elections typically require shareholder consent, while partnership elections may be made by the managing partner. Verify the consent requirements in each state where the election will be made.

Can C-Corps use a PTE election?

No. C-Corps are not pass-through entities and pay corporate-level federal income tax. The PTE election is designed for entities that pass income through to individual owners. C-Corp shareholders receive dividends, not pass-through income, so the SALT cap issue doesn't arise in the same way. See our entity selection guide for how C-Corp taxation differs.

What happens to the state credit if it exceeds the owner's state tax liability?

It depends on the state. California allows a 5-year credit carry forward. New York permits indefinite carry forward. Some states (e.g., Connecticut) allow partial refundability. A few states do not permit carryover, making the election less valuable for owners with minimal state income tax outside the pass-through entity. Model the credit utilization before electing in those states.

Does the PTE election still work if the SALT cap is repealed?

Possibly not, depending on the form of repeal. If Congress fully repeals the SALT cap, individual owners would again be able to deduct state taxes paid on Schedule A without limitation — making the entity-level election unnecessary for most clients. As of 2026, partial modifications have been proposed but the $10,000 cap remains in effect. Continue implementing PTE elections for applicable clients until the law clearly changes.

How do estimated PTE tax payments work?

States that require in-year estimated payments typically follow a quarterly schedule (similar to federal estimated taxes). The entity estimates its taxable income attributable to each owner, applies the PTE rate, and remits the payment. New York, Virginia, and New Jersey all require estimated PTE payments. Missing estimated PTE payments can result in underpayment penalties at the entity level. Coordinate the entity's estimated payment schedule with owners' individual estimated payment schedules to avoid duplication.

Can a sole proprietor or single-member LLC use a PTE election?

Generally no. PTE elections require a multi-owner entity. Sole proprietors and single-member LLCs disregarded for federal tax purposes do not qualify. These clients continue to be subject to the $10,000 SALT cap on Schedule A. The primary strategy for sole proprietors is maximizing other deductions, or considering whether forming a partnership entity (bringing in a spouse, family member, or business partner) could qualify for a PTE election.

What is the IRS authority confirming that PTE elections are legitimate?

IRS Notice 2020-75 (published November 9, 2020) is the controlling authority. It confirmed that states may impose income taxes directly on partnerships and S-Corps (rather than only on their owners), and that such taxes are deductible at the entity level under IRC §164(a) without limitation. This resolved uncertainty that existed before Notice 2020-75 and triggered the wave of state PTE election laws enacted from 2021 onward.

How Arvori Helps CPAs Implement PTE Elections at Scale

PTE elections require tight coordination across entity filings, owner individual returns, estimated payment schedules, and state-by-state rules. Arvori's platform helps CPAs manage client communication, track election deadlines, and coordinate year-end planning conversations — so no client falls through the cracks during the March election window. Learn how Arvori supports CPA firm growth at arvori.app.